One of the largest and most rapid bank failures just unfolded.
Why did Silicon Valley Bank fail? There are several reasons why the bank fell so quickly, but it mainly boils down to interest rate risk, liquidity risk, and a bad business model without any oversight or regulation.
Interest Rate Risk
SVB was exposed to interest rate risk as the Fed has been busy raising interest rates in an attempt to combat inflation. Banks will face this risk when interest rates rise rapidly over a short period of time. That is the exact scenario that has been playing out over the past year.
SVB had over half its assets tied up in U.S. Government Bonds. When yields go up, prices on bonds go down. This only becomes a problem if the bank is forced to sell the bond at a loss. Normally, the bank can just hold the bonds until maturity and then collect the original face value. Unfortunately for SVB, they had to do the former to raise cash.
Most of SVB’s customers were in the tech industry, and many of them were startups. As the tech industry has been struggling, SVB’s customers started to withdraw their deposits to fund their businesses. In a move to raise capital, SVB sold their bond positions turning an unrealized loss to an actual loss.
Liquidity Risk
Liquidity Risk is the risk that banks won’t be able to meet their financial obligations when they come due without occurring a loss.
As SVB’s customers were withdrawing their assets, the bank was forced to sell $21 billion in securities to meet its obligations. The sale caused a $1.8 billion loss.
This decision caused customers to lose faith in the bank, and one of the largest and swiftest bank runs in history ensued.
Bank deposits of up to $250,000 are insured by the FDIC, but many of SVB’s depositors had much more than this in their accounts. In fact, over 88% of SVB’s deposits were uninsured.
Regulations
Post 2008, many new regulations were imposed on banks to keep them from failing. Surprisingly, SVB was in compliance with these regulations, but their balance sheets were not mirroring the industry averages. While many banks were keeping well over 10% of their assets in cash, SVB had only 7% in cash holdings. Conversely, their 55% of assets in government bonds was well above the 24% industry average.
So, if SVB was following the rules, then why did they collapse so fast? The reasons are many, but a lot of people are pointing to multiple factors.
The Dodd-Frank Act was signed into law by then President Obama as a result of the 2008 financial crisis. A part of that legislation required banks with more than $50 billion in assets to submit to stress testing. Fast forward to 2018, and parts of that legislation were loosened. The updated legislation axed stress testing requirements for regional banks with less than $250 billion in assets.
The updated law was mostly in response to smaller banks criticizing the law. They argued that they shouldn’t be subject to the same scrutiny as larger institutions. The subsequent rollback of the original law may have been a contributing factor in the SVB collapse.
The other factor is that there is evidence that the laws that were in place weren’t being enforced in any meaningful way. SVB was left to do business as it pleased while regulators turned a blind eye.
Bad Business
The other factor in the SVB collapse could be that they were simply running with a bad business model. Their business was concentrated in the volatile tech sector, and they weren’t holding enough assets in liquid cash. Many of the businesses and venture capitalists holding deposits at the bank became strapped for cash recently causing the historic bank run that drove SVB under in a matter of days.
Isolated Incident?
The good news is that it appears that the collapse at SVB seems to be an isolated incident, and that things aren’t likely to spread to other banking institutions. Most large banks are much more diversified and are holding more liquid assets than SVB did. The government has also stepped in and is insuring all SVB deposits.
Conclusion
Why did Silicon Valley Bank fail? The reasons are many, but a perfect storm of massive withdraws on a bank that had most of its assets tied to government bonds unfolded in a matter of days. Without the ability to support withdraws the bank was forced to raise cash by taking a loss on the sale of government securities. The rest was history.
Read Also:
Understanding Business Financing
High Yield Savings Accounts are Back
How to Recover From Personal Budget Setbacks
Writer and Investor. Based in the Pittsburgh, PA area, Brian holds full-time employment as a Warehouse Manager for an electronics firm. Brian enjoys wealth building, investing, gardening and the great outdoors. Brian holds a B.A. in Environmental Studies from the University of Pittsburgh and an MBA from Robert Morris University.